Contagion crisis intensifies; Spain yield soars

Investors continue dumping peripheral bonds in wake of Irish bailout

By

WilliamL. Watts

LONDON (MarketWatch) — The euro zone’s sovereign-debt crisis intensified Tuesday, with yields on Spanish, Italian and other peripheral government bonds soaring in the wake of a weekend meeting of European Union finance ministers that failed to soothe fears of the potential for future defaults.

The yield on 10-year Spanish government bonds jumped to around 5.63%, strategists said, a day after surging to 5.43%.

The move sent the yield premium demanded by investors to hold 10-year Spanish debt over comparable German bunds to more than three full percentage points.

Bond yields move in the opposite direction of bond prices.

“Ireland’s bailout did nothing to ease the euro-zone debt crisis: it might have even made it worse,” said Steven Barrow, currency and fixed-income strategist at Standard Bank. “For now the market sees a pattern emerging and the next piece of the bailout puzzle seems to be Portugal, with Spain to follow after that.”

Interview: Japanese Foreign Minister Seiji Maehara

(2:57)

Seiji Maehara, Japan's foreign minister, speaks with WSJ's Adam Horvath about his reluctance to hold six-party talks after North Korea's attack on South Korea, and about whether China poses a threat.

The yield on 10-year Italian bonds also rose for a second day to hit 4.77% from around 4.64% on Monday. Portuguese, Greek and Irish bond yields also rose. And outside the periphery, the Belgian 10-year bond yield continued to climb, hitting 3.97% versus around 3.86% on Monday.

The cost of insuring peripheral euro-zone government bonds against default using derivative products known as credit default swaps also rose sharply.

The euro
EURUSD, -0.5086%
dipped below the $1.30 level versus the U.S. dollar for the first time since mid-September and changed hands in recent action at $1.3003, a loss of 0.8% from Monday.

The recent pressure on Italian bonds is particularly worrying since the nation’s debt had been relatively immune to the most recent round of sovereign-debt fears, said Gary Jenkins, head of fixed-income research at Evolution Securities, in a note.

“Spain has a funding requirement in excess of 150 billion euros ($196.7 billion) for 2011 and Italy needs close to €340 billion. With the market moving rapidly onto Spain and Italy it is possible that too big to fail becomes too big to bail,” Jenkins said.

European Union finance ministers on Sunday finalized an €85 billion aid package for Ireland, which became the second country in the 16-nation euro zone to seek a bailout.

The EU and International Monetary Fund provided Greece a €110 billion package in the spring after Athens was shut out of credit markets by rising borrowing costs.

More importantly, officials outlined plans for a new European Stability Mechanism that will take the place of the €440 billion bailout fund put in place after the Greek bailout. The new program, which would take effect in mid-2013, includes provisions that could require private bond holders to take write-downs in the event of future sovereign-debt crises. Read about the reaction to the ESM

The plan watered down German calls to automatically impose haircuts on private bond holders, but the outline also left significant uncertainty and failed to soothe investor worries over their potential exposure to any future debt restructuring, analysts said.

Meanwhile, the intensification of the surge in bond yields puts the onus on European authorities to act, economists said, although options appear limited.

“Of course, it is possible that euro-zone officials and the IMF can break the pattern just in time. But the markets are not convinced,” Barrow said.

If bond yields continue to rise sharply “we may see a much faster move toward a de facto fiscal union with a central debt management office and single European government bond, possibly under the auspices of the [European Financial Stability Facility] initially,” Jenkins said.

A “muddle-through” option, alternatively, would involve the European Central Bank announcing a “shock and awe” amount of quantitative easing to vacuum up a significant chunk of euro-zone government-bond issuance, he said.

Jenkins acknowledged that such a move would mark the “sharpest of U-turns,” since ECB officials have signaled they intend to announce the scaling back of the central bank’s special liquidity measures at Thursday’s meeting.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.